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Trade and Industry Department The Government of the Hong Kong Special Administrative Region
Brand Hong Kong - Asia world city

A Report on Support Measures for Small and Medium Enterprises

Chapter 3

Present situation of SMEs and their challenges

The role of SMEs

3.1An entrepreneurial and industrious workforce has made Hong Kong an important international financial, trade and transport hub. Making full use of Hong Kong's advantages in business and commerce over the last hundred years, the people of Hong Kong have contributed to Hong Kong's economic take-off. Indeed, a number of international enterprises in Hong Kong today started their businesses as SMEs. This shows that SMEs are the primary pillar and driving force of Hong Kong's economic development.

3.2According to a sample survey conducted by the Census and Statistics Department (C&SD), as at December 2000, there were approximately 290 000 SMEs in Hong Kong, accounting for 98% of local enterprises. They employed more than 1.36 million people, i.e. about 60% of private sector employees. SMEs were engaged in different trades and industries. Nearly 90% of them were enterprises with fewer than 10 employees (see Figure 3-1 and Appendix 6).

Number of SMEs by Size

3.3Flexibility and lower start-up and operating costs have enabled SMEs to spring up, and reposition and adjust themselves quickly in response to market and economic changes. Moreover, they can easily expand or contract within a short period of time, to embrace new business opportunities or pull out where there is an over-supply. SMEs have not only survived the impact of big enterprises and the law of economies of scale, but have carved out niches for themselves which enable them to co-exist with big enterprises. Many SMEs are strategic partners of big enterprises.

3.4SMEs play a pivotal role in the labour market as well. In Hong Kong, nearly 60% of the working population in private sector are employed by SMEs. Not only do SMEs provide diversified working experiences for our workforce, they also help enhance their quality. Indeed, SMEs serve as the starting point for career path of many young fresh graduates, the venue for entrepreneurs to realise their vision and aspirations, and the life-long workplace for many people.

3.5The Committee fully recognises the contributions of SMEs in promoting the growth of Hong Kong's economy, providing job opportunities, enhancing the quality of human resources, nurturing a culture of entrepreneurship, fostering creativity, and opening up new business opportunities. The Committee firmly believes that SMEs will play an increasingly important role in the new economy.

Challenges facing SMEs

3.6Having taken stock of the status quo of SMEs as well as the challenges they face, the Committee has arrived at a number of observations as set out below.

(A) Macroeconomic challenges

3.7The Committee reckons that SMEs in Hong Kong have to meet the challenges brought about by three major economic developments, namely the globalisation of world economy, China's impending accession to the World Trade Organization (WTO), and the new economic order that has taken shape as a result of advances in information technology (IT).

(1) Globalisation of world economy

3.8Globalisation of world economy facilitates free import and export of goods and services, and gradually removes restrictions on investment and tariff barriers. Production processes are therefore no longer limited to a single region. This in turn will give rise to market and price competition globally. Globalisation enlarges the market for SMEs on the one hand, and exposes them to worldwide competition, including competition from low cost regions, on the other. Local SMEs have to be proactive in mapping out marketing strategies, with a view to consolidating existing markets and capturing new markets.

(2) China's accession to the WTO

3.9China's accession to the WTO and, in consequence, the opening up of the vast the Mainland market will have profound impact on SMEs in Hong Kong. While enormous business opportunities will be generated, there will be keener competition from foreign enterprises with direct presence in the Mainland. Moreover, as foreign enterprises will be able to invest directly in the Mainland, Hong Kong enterprises have to reposition themselves and to gear up for a more robust intermediary role, in order not to be left behind.

(3) New economic order

3.10The widespread use of IT has brought about the emergence of a knowledge-based new economy. An important feature of the new economy is the growing expectation of customers on the quality of goods and services, as a result of market information becoming easily accessible through the Internet and electronic commerce (e-commerce). Innovativeness, quality and added value of products and services, rather than price, has become the crucial factors of success in competition. Moreover, an increasingly short product cycle calls for enhancement in production techniques, supply chain management, and IT application.

(B) Challenges from local economy

(1) Business environment

3.11As Hong Kong becomes a world-class city, it unavoidably becomes a more expensive place to live and to do business. Indisputably, the cost of living is high in Hong Kong, and so are rents and salaries, particularly if we compare them with those of neighbouring economies. From a microeconomic perspective, the solution to high operating costs lies in the concerted efforts of all parties concerned to exercise effective cost control to stabilise price levels. However, to address the problem in the long run, enterprises need to enhance productivity and value-added capability, focus on innovation, make maximum use of technology, open up new markets, upgrade product/service quality, and enhance market knowledge.

3.12The Committee has made reference to various survey findings and ratings given by a number of prestigious international organizations(Note 2) on the business environment of Hong Kong and other major economies. It has also made reference to the findings of similar surveys conducted by local organizations(Note 3). Overall, Hong Kong continues to receive very high ratings in a number of authoritative international surveys, notwithstanding the impact of the Asian financial turmoil on its economy. For example, in the "Economic Freedom of the World: 2001 Annual Report" issued in April this year by the Cato Institute of the US and the Fraser Institute of Canada, Hong Kong was once again rated the world's freest economy (see Table 3-1).

 

Table 3-1 : Survey findings and ratings by prestigious international
organizations on the business environment of major economies around the world
  Economic Freedom of the World: 2001 Annual Report published by the Fraser Institute of Canada and the Cato Institute of the United States 2001 Index of Economic Freedom published by the Heritage Foundation of the United States The World Competitiveness Yearbook 2001 published by the International Institute for Management Development The Global Competitiveness Report 2000 published by the World Economic Forum

Hong Kong

1

1

6

8

Singapore

2

2

2

2

New Zealand

3

4

21

20

The United Kingdom

4

7

19

9

The United States

5

5

1

1

Australia

6

9

11

12

Ireland

6

3

7

5

Switzerland

6

9

10

10

Luxembourg

7

5

4

3

The Netherlands

7

8

5

4

Canada

9

14

9

7

 

3.13Surveys conducted by local organizations also yield very similar results, indicating that the community is generally satisfied with the business environment of Hong Kong, and is optimistic about business prospects.

3.14According to the United Nations Conference on Trade and Development, foreign investment in Hong Kong in 1999 was among the highest in Asia, second only to the Mainland. The number of multinational corporations setting up regional headquarters or regional offices in Hong Kong surged from 2 068 in 1995 to 3 001 in 2000 (see Figure 3-2). Judging from the foreign investment in the territory, Hong Kong's business environment remains attractive in Asia.

3.15The aforementioned surveys show that Hong Kong has an edge over its competitors in many areas, namely, simple and low taxation, user-friendly procedures for starting and winding up businesses, stable political environment, free trade, market-oriented monetary and financial policies, freedom of speech, a sound and independent legal system, a clean government, close relationship with major markets in the world, its role as an intermediary between the East and the West in international trade, sound IT infrastructure, and quality managerial talent. But whilst Hong Kong remains attractive to international investors, there exist some causes for concern. For example, there is still room for improvement in terms of progress in and awareness of science and technology. Other areas of concern include high operating costs, less than satisfactory environmental quality, and a dearth of technological professionals and research and development capabilities.

3.16he Committee is of the view that efforts should be taken to improve the aforementioned areas. On the part of SMEs, they should make good use of Hong Kong's advantage as an ideal place for conducting business, and focus on the development of high value-added and quality products/services, with a view to offsetting the high operating costs and establishing their own niches.

3.17The Committee notes that the new global brand publicity programme launched by the Government in May this year, which positions Hong Kong as "Asia's World City", serves to highlight the unique advantages of Hong Kong as a major business and commercial centre in the Asian region, a gateway to the Mainland of China, as well as a city where opportunities, creativity and entrepreneurship converge. The Committee believes that this new global strategy will further enhance Hong Kong's international status and therefore help raise the profile of Hong Kong SMEs in overseas markets.

(2) Financing

3.18Financing is a major concern to SMEs, as it affects their business development. Traditionally, SMEs in Hong Kong rely on self-financing, i.e. funds from shareholders and their family members, as their primary source for raising capital. Secured loans from banks come second. Before the Asian financial turmoil, the booming local property market prompted many SMEs to obtain loans from financial institutions with their properties as collateral. This was a particularly common practice for many SMEs whose business and financial conditions failed to fully meet the financial institutions' criteria for approving unsecured loans, and those which wanted to secure loans with disclosure of minimal information. As the prices of local properties plummeted after the financial turmoil, SMEs had found it hard to secure loans with their properties as collateral. Instead, a firm's financial status and business prospects have become important considerations for financial institutions in approving loans. In other words, market forces have caused the lending mechanism to evolve from counting on "bricks and mortar" as collateral to counting more on other factors such as enterprises' financial status, management quality, repayment record and business prospects as the criteria for approving unsecured loans. In the long run, such a change will help to get rid of the undesirable phenomenon of requiring collateral in the form of properties as the prerequisite for approving loans, and instead encourage banks and financial institutions to make more objective assessment of loan applications on the basis of enterprises' potential.

3.19However, the Committee is aware that the "bricks and mortar" culture, which banks and SMEs are both accustomed to, cannot be changed overnight. It takes time for banks to learn about the operation of SMEs in order to have a better understanding of the credit risks of SMEs in general, and to set up an effective support mechanism for assessing the credit risks. SMEs on their part need to do away with their traditional disregard to financial management, transparency and record keeping. Instead, they need to start maintaining proper financial accounts so as to facilitate banks or financial institutions to analyse and assess risk when considering their loan applications.

3.20The Committee believes that the financing problems which SMEs currently encounter are mainly due to the fact that neither banks nor SMEs are fully geared for the change in the loan market. That said, the Committee is aware that in the past year or so, an increasing number of local banks and financial institutions have introduced a variety of loan facilities specifically for SMEs. With the exception of some specific financing activities, such as loans for the procurement of business installations and equipment, which are still not commonly available, the lending market at present is very favourable to SMEs seeking to raise capital. Therefore, it is important for SMEs to quickly improve their weaknesses in financial management to take advantage of the changes that are taking place in the market. By doing so, SMEs will stand a better chance of obtaining financing.

3.21As their businesses grow, SMEs will have a greater demand for capital to support a great variety of activities, ranging from staff development and application of new technologies, to acquisition of new equipment and marketing. The Committee anticipates that as SMEs seek to capitalise on the business opportunities brought about by the new economy as well as China's accession to the WTO, they will have an even greater demand for capital. This makes it more pressing for SMEs to strengthen their financing capability.

3.22As a matter of fact, given Hong Kong's well-developed financial market and the sophisticated financial products and services available, there should be a wide range of financing instruments to meet the needs of SMEs. However, most SMEs do not seem to be fully aware of the financing means available in the market. Besides, SMEs in general are unfamiliar with the financial management requirements which financial institutions expect of their borrowers. As a result, SMEs often run into difficulties when trying to raise capital.

3.23The Committee has also noted that the insurance and credit advisory services provided by the Hong Kong Export Credit Insurance Corporation (ECIC) have greatly reduced local exporters' risks arising from transactions with overseas buyers on credit terms. They have also helped ease SMEs' liquidity problems arising from deferred/default payments. The Committee believes that ECIC's services, if strengthened, can further relieve the financing problems facing SMEs in export trade.

3.24Finally, while recognising the importance of financing to the development of SMEs, the Committee would like to bring home the message that financing is not the only difficulty that deserves SMEs' attention. SMEs have to realise that they will not be able to stand up to new challenges simply by solving financing problems. It is equally important for SMEs to work on other areas at the same time. The Committee nevertheless accepts that, with their financing problems solved, SMEs will be better equipped for expansion and will have greater financial strength to invest in technology and staff training. This in turn will strengthen their competitiveness and facilitate their long-term development.

(3) Corporate governance and culture

3.25With the increasing globalisation of world economy, the rules of business and commerce are also undergoing a process of globalisation and standardisation. These rules impose certain requirements on management methods, corporate integrity and governance standards of enterprises. Some large local enterprises have acquired a good understanding of these rules long ago, and have been endeavouring to perfect their governance methods and procedures. As a result, their current governance standards are fully comparable to those of multinational corporations in other regions. Although SMEs tend to have a simple management structure, they too must establish a well-defined relationship, as well as clear division of authority and responsibilities among their stakeholders, such as the management, board of directors, shareholders, employees and creditors. Modern enterprises have to observe modern rules of business.

3.26The governance culture in the new economy emphasises initiative, an inquiring mind, and team spirit. It looks for employees who not only are ready to innovate and experiment, but also observe the rule of law and integrity. As this new governance culture is likely to be incompatible with the existing culture, it is impossible for changes to take place overnight. Nor can we expect the changes to occur naturally. Instead, the changes must be top down, complemented with appropriate training and support with a view to building a new corporate culture to reform the corporate governance model in order to meet the challenges of the new economy. SMEs which fail to reform in this regard will lose out in the new economy.

3.27Faced with the challenges brought about by the three major developments in the world economy, SMEs need to learn and reform in respect of management skills and corporate culture if they are to keep pace with the development of their businesses, develop their capabilities to foresee and manage changes, as well as capitalise on new business opportunities. However, judging from their present corporate culture and governance standards, most SMEs have not fully acquired such capabilities.

3.28The Committee considers that SMEs' weaknesses in corporate governance have resulted in the following shortcomings :

  1. Weak corporate governance framework

    Under the influence of their inherent business culture, many SMEs have weak governance framework. Rigorous corporate governance should include proper supervision over the management. To effectively monitor the management, shareholders and creditors must be provided with sufficient information for them to assess the risks facing the enterprises. Since most enterprises do not need external financing at the start-up stage, they are unaware of the importance of governance framework to their financing and development. However, as enterprises grow, their demand for funds will increase to an extent that it can no longer be met by the shareholders alone. Hence, external capital is essential to enterprises at the development stage, and the effectiveness of their governance is a deciding factor in their success of obtaining external capital.

  2. Failure to cultivate corporate culture that fits in with the new economy

    In the new economy, the competitiveness and viability of enterprises, regardless of their sizes, depend increasingly on the development of successful strategic partnership with other firms. An enterprise's bargaining chips in this respect include its financial strength, track record and, more importantly, its perceived capability to cope with future changes. For SMEs to manage changes, they need to cultivate a new corporate culture in support of reforms and innovations. However, many are still running their businesses with traditional modes of operation and are not ready for change. For instance, little importance is attached to corporate management system, financial management, division of authority and responsibility, as well as rules and regulations. This has caused them to keep to primitive modes of governance. Some SMEs lack a good understanding of the concept of corporate governance and therefore fail to apply modern management skills and introduce timely reforms to their mode of governance.

(4) Human resources

3.29Quality human resources, including managerial, technological and frontline personnel, are of paramount importance to the survival and development of SMEs in the ever-changing business environment. Coordinated efforts on the part of the Government, training institutes, employers and employees are required in order to raise the overall quality of the local workforce. The Government has to draw up a long-term development strategy to ensure that there will be adequate supply of quality manpower in Hong Kong. Training institutes must keep a close watch on the needs of society and provide value-added courses in a timely manner, with a view to maintaining a high quality workforce. Apart from pursuing continuous self-enhancement, employers should also encourage and assist their staff to receive training in order to keep their enterprises abreast with the times and maintain their competitive edge. Meanwhile, employees have to acquire new knowledge and enhance their skills, with a view to maintaining their competitiveness in the labour market.

3.30The Committee, however, notes that most SMEs do not attach much importance to enhancing the quality of their human resources. The main reasons include the following :

  1. given SMEs' small scale of operation and their limited number of staff, those engaging in SMEs, ranging from employers to the most junior employees, are so preoccupied with their work that they cannot or are unwilling to squeeze time for training necessary for enhancing their skills or competence;
  2. as staff turnover rate is generally high in SMEs, some SME employers consider that the fruit of investing in staff training may be reaped by their counterparts;
  3. some SME employers do not recognise the significance of staff training in boosting their staff's productivity and capabilities; and
  4. some SME employers take the view that staff training is not a priority when the enterprises are short of capital.

3.31The Committee is of the view that resource allocation for staff training and self-enhancement in support of long-term business development will be a major challenge in resource management for SME employers.

(5) Technology application

3.32The successful application of technology to maintain a competitive edge is another key factor determining whether an SME can survive and prosper. The application of technology in SMEs involves two major areas, namely applied technology and IT. The Committee notes that SMEs in general have certain knowledge about the new technology and equipment applicable to their trade. However, constrained by shortage of capital, SMEs often fail to introduce new technology and equipment, therefore undermining their productivity and efficiency.

3.33Regarding IT application, the Committee has made reference to the "Survey on Information Technology Usage and Penetration in the Business Sector", conducted by the C&SD in 2000. The survey shows that large enterprises in Hong Kong are making good progress in IT application, with nearly 90% of them having personal computers and over 70% having access to the Internet. As for SMEs, the survey reveals that there is a very notable gap in IT application between medium enterprises and small enterprises (i.e. those with fewer than 10 employees). The former is not far behind the large enterprises in IT application. For instance, nearly 80% of them have personal computers, and over 60% have access to the Internet. As for the small enterprises, only less than 50% of them have personal computers and about 30% have access to the Internet (See Table 3-2).

 

Table 3-2 : IT application in enterprises in Hong Kong

State of IT application

Overall

Large Enterprises

Medium Enterprises

Small Enterprises

Percentage of organizations (Note 4) equipped with personal computers

52.5%

92%

78%

48%

Percentage of organizations having access to the Internet

37.3%

78%

63%

34%

Percentage of organizations having their own webpage/website

7.3%

43%

18%

5%

 

3.34The survey reveals some worrying phenomena. Among those SMEs which do not have computers, only less than 5% have plans to install them. Among those that have no such plan, almost 75% consider that installing computers would not be beneficial to their businesses; whereas 16% indicate that a lack of computer-literate staff has inhibited them from making good use of IT.

3.35The Committee believes that the next few years will be a crucial time in determining whether SMEs can successfully ride on the IT superhighway. Not only will SMEs need to use IT in their operation to cut costs and enhance productivity, the prevalence of e-commerce has also brought about a revolutionary impact on the mode of operation of SMEs. In particular, the use of mobile phones in e-commerce (mobile commerce) is an emerging trend. The world has begun to notice the phenomenon of "digital divide" in societies where enterprises or individuals who can make good use of IT become more and more successful, while those who cannot gradually lose their competitiveness. Therefore, if SMEs fail to apply IT and provide proper training for their staff to prepare for the age of e-commerce and mobile commerce, their development and competitiveness will be seriously hampered in the long run. On the other hand, the Government also has to ensure an adequate supply of IT personnel on the market to assist SMEs in IT application.

(6) Market expansion

3.36Market expansion is an important step for SMEs to develop. To secure and increase their market share, SMEs must understand the changes and trends of the market, and to map out their strategies in time. However, the Committee has found that, due to their limited sizes and resources, SMEs often cannot accurately master market information and therefore fail to grasp business opportunities.

3.37Take the local market as a case in point. The local economy has slackened in recent years as a result of the Asian financial turmoil, leading to a plunge in local consumption power and desire. At the same time, more and more Hong Kong people travel north to the Mainland to spend and shop, attracted by the cheaper prices there. That has dealt a further blow to the local retail and catering sectors.

3.38In an increasingly globalised world economy, SMEs have to face not only internal competition but also international challenges. However, constrained by resources and ability, most SMEs have not been able to use IT to collect and analyse overseas market information. Nor have they been able to frequently participate in overseas promotion/trade fairs. As a result, SMEs are constrained in their ability to penetrate into the distribution network of overseas markets, establish their network with overseas buyers, and foster strategic partnership with overseas enterprises.

3.39In the Mainland market, our SMEs have abundant experience in doing business there and have been playing the role of the middleman in fostering closer economic and trade relationship between the two places since as early as 1978 when the Mainland implemented its economic reform and open door policy. However, as Mainland's policy restricts the proportion of goods manufactured in the Mainland by outside investors for internal distribution, Hong Kong's SMEs in the Mainland mainly manufacture products for overseas buyers, i.e. they are engaged in processing trade such as original equipment manufacturing, with little emphasis on developing their own brands or products. Also, they rarely venture into the Mainland domestic consumer market. With China's impending accession to the WTO and the active development of the cities and provinces in western China, the Mainland market will open further. Its market economy will develop and its economy will transform at a quicker pace. Rules and regulations governing market liberalisation will gradually be implemented and given more transparency; and foreign trade and investment activities will significantly increase. Our SMEs must get prepared for all these changes.

3.40It is not easy for SMEs whose resources are limited to stand up to and meet the enormous challenges of the market. Hence, the Committee is of the view that the Government and other support organizations such as the Hong Kong Trade Development Council (TDC) must render more assistance to SMEs, to help them gain market access by collecting, analysing and releasing the most up-to-date market information; providing them with professional consultation services; and helping them resolve the difficulties encountered in market expansion.


(Note 2) : Reference has been made to the following survey reports published by prestigious international organizations:

  1. The annual Index of Economic Freedom published by the Heritage Foundation of the US;

  2. Economic Freedom of the World: Annual Report published by the Fraser Institute of Canada and the Cato Institute of the US;

  3. The annual Global Competitiveness Report published by the World Economic Forum; and

  4. The World Competitiveness Yearbook published by the International Institute for Management Development, Lausanne Switzerland.

(Note 3) : Reference has been made to the following survey reports published by local organizations:

  1. The annual Business Confidence Survey published by the Better Hong Kong Foundation and International Hong Kong;

  2. The quarterly Business Operating Environment Index for SMEs published by the Hong Kong Productivity Council;

  3. The Business Outlook Survey conducted by the American Chamber of Commerce in Hong Kong;

  4. Business Confidence Survey conducted by the British Chamber of Commerce in Hong Kong among its member companies;

  5. Surveys of Hong Kong's Business Environment conducted by the Hong Kong Japanese Chamber of Commerce and Industry among Japanese businessmen;

  6. The annual Survey on the Number of Regional Headquarters and Regional Offices in Hong Kong conducted by the Census and Statistics Department;

  7. Related surveys conducted by the Hong Kong Institute of Asia-Pacific Studies of the Chinese University of Hong Kong and the Hong Kong APEC Study Centre; and;

  8. Business Prospects Survey conducted by the Hong Kong General Chamber of Commerce.

(Note 4) : Organizations are categorised according to their respective number of employees as at 30 December 1999. Large enterprises refer to those with 100 or more employees in the manufacturing sector, or those with 50 or more employees in non-manufacturing sector. Small enterprises broadly refer to those, irrespective of trades, with fewer than 10 employees. The remainder is counted as medium enterprises.

 

Chapter 4 : Proposals to help SMEs start, build and expand their businesses

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